Intuitively, digitalisation is a game-changer for catalysing accelerated, equitable development in emerging markets. And in numerous countries so far, digital versions of basic services have already proven critical for empowering entrepreneurs and consumers. Mobile money accounts are perhaps the classic example, with digitalisation enabling a sea change in availability of financial services. With near-zero marginal cost, they can now be offered profitably to ‘low ticket’ customers without the need for costly, high-risk accompanying physical infrastructure.
It is puzzling, therefore, to read that in the early stages of what should be a development-boosting digital paradigm shift, growth even in notable emerging market success stories such as India is becoming more unequal. The share of corporate profits is becoming increasingly tilted in favour of major conglomerates just as opportunities should be knocking for the country’s vast ranks of micro-entrepreneurs and informal labourers. Indeed, creating gainful employment for India’s emerging ‘demographic dividend’ is critical to ensuring the country fulfills its potential in the decades ahead, and is not instead lumbered with the social liability of mass un(der)employment.
Our research on emerging digital businesses globally has shown us that not all of these services are in fact empowering to users, and many instead favour short-term monopolistic behaviours at the expense of a more sustainable, customer-led approach which would in our view also create more shareholder value over the long-term.
Take marketplaces for example: digital marketplace platforms represent a modern incarnation of a concept as old as time, albeit with a physical market square enjoying a relatively limited and localised ‘network effect’ relative to national online platforms. It is precisely the near endless reach of these digital platforms which represents such a compelling opportunity for SMEs. Previously limited to their surrounding streets when hunting for buyers, Indian SMEs can now access customers as far away as a third-party distributor can reach. Many of these SMEs are in fact quite specialized B2B vendors, and thus highly competitive even within their newly expanded addressable markets.
Yet the digital platforms which open up these larger markets to Indian SMEs must allow them to continue growing sustainably, rather than seeking to monopolistically capture the small initial benefits of digitalisation. To our minds, this tends to mean a subscription-based model, along the lines of IndiaMart, rather than the commission-based model which prevails in the developed world. Amazon, the commission king, now earns (per a recent report by Marketplace Pulse) an average cut of over 50% of each marketplace sale once all services are included. Such a model requires maintaining unassailable market dominance and vast scale, yet the economics are surely unsustainable at each individual merchant level.
Founded 27 years ago, IndiaMart was instead a business which from inception was designed to solve problems for SMEs. In the years since, it has developed such a strong reputation for value add that SMEs willingly pay up front for the service, almost unheard of in the Indian context, and grows largely through word of mouth. Through interviewing its clients, we have learned that the subscription fee typically pays itself back within a couple of months.
IndiaMart may not display Amazonian aggression when it comes to pricing, but its benefits amply from both the continued growth of its existing customers (for example by migrating them to more premium offerings) and the expansion of its paying user base. With a 60% market share today in the B2B classifieds space, IndiaMart still has just 210,000 paying customers today. In other words, there is a long runway of growth both in attracting more of these existing SMEs to the platform, and in the expansion of this market as India’s population and economy grows further.
Speaking to IndiaMart’s CEO, one gets a sense of his singular focus on building a solution which genuinely adds value to its customers on both sides of the transaction. In the case of Amazon, in contrast, one senses that merchant experience and economics have been steamrollered in deference to the buyer – a solution which works only as long as the endless churn in suppliers continues. In the case of IndiaMart, affordability has also always remained key. While larger in number, India’s SMEs, as one might expect, have far lower individual spending power than their developed world counterparts.
But catering to this vast number of individually smaller clients does not require a concessionary business or investment strategy. In fact, IndiaMart is highly profitable, with EBITDA margins already hovering around 30% and returns on capital employed (ex-cash) in excess of 100% thanks to a negative working capital cycle. IndiaMart’s purposeful approach to growth may not match the breakneck speed of digital monopolists, but still runs at a highly attractive (and more sustainable) 20% or so – more than enough (alongside its formidable cash generation) to reward the shareholders which help this company catalyse the development of India’s millions of underserved SMEs.
This material is being furnished for general informational and/or promotional purposes to professional investors only. The views expressed are those of Arisaig Partners and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact, nor should any reliance be placed on them when making investment decisions. This material does not constitute independent research and is not subject to the protections afforded to independent research.
The statements and views expressed herein are subject to change and may not express current views. Arisaig Partners makes no representation or warranty, express or implied, regarding the accuracy of the assumptions, future financial performance or events. Emerging markets are generally more sensitive to economic and political conditions than developed markets and may be more volatile and less liquid than other investments.
All information is sourced from Arisaig Partners and is current unless otherwise stated. Issued by Arisaig Partners (Asia) Pte. Ltd. Not for public use or distribution. Arisaig Partners (Asia) Pte. Ltd is licensed and regulated by the Monetary Authority of Singapore.